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Shriro – Gift horse or VIP dog food?

When a stock has a profit downgrade a cardinal market rule is wait. Profit downgrades, it seems, nearly always come in threes.

Buying stock after a second profit downgrade may be like looking a gift horse in the mouth but may also be like backing the nag still running in the 8th race at Doomben.

This is the dilemma I found myself in this past week after Shriro Holdings blindsided the market with its second profit downgrade in 3 months for the second half of the 2018 year. This is normally a period it generates 70% of its revenue.

The Shriro share price has more than halved. Trading now at 51 cents it is well under its net tangible asset backing of 58 cents. This is a high former 10% dividend payer I have previously written about and the market is wondering whether the company can pay a final dividend and whether dividends next year drop to zero as the company rebuilds its fortunes.

NPAT (Net profit after Tax) is forecast between $7-8 million. This is roughly half of broker’s forecasts of 6 months ago. And it comes off a downgrade at the half year when NPAT guidance was lowered slightly to $10.5 – $11.5 million.

The two major headwinds affecting profit are the appliance division – cooktops and stoves. It is exposed to the local new housing and renovation market (particularly commercial residential). The second headwind is Donald Trump’s new 25% tariff on Chinese manufactured goods.

The USA delivered a major launch this year for the Everdure by Heston charcoal and gas BBQ range. It received big fanfare and enthusiastic retailer response. BBQ’s and grills manufactured in China (Shriro)now are subject to the 25% tax . USA retailers are unsure how a premium product like Everdure will sell at higher tariff induced price point.

This is a USA BBQ and grill retailer industry wide issue because nearly all big brands are manufactured in China. It is big business – estimates of annual BBQ and grill sales are close to 1 billion.  Wal Mart, for instance, sources all its generic BBQ’s from China

Ultimately retailers will have to restock product, however future orders may be for smaller numbers. For the moment the majority of large BBQ and grill retailers are sitting on their hands. 

Those orders are likely to be pushed into the 2019 calendar year. And the USA market with the help of BBQ sales in Europe and Germany was expected to pick up the slack of margin compression and appliance range transition costs.  

Shriro management are well underway with a restructuring plan for the appliance division with two showrooms in Victoria and Queensland earmarked for closure. Also in 2019  new product appliance innovations in ovens and cooktops are to be launched which are expected to strengthen the company’s market position.

There is no doubt product innovation like the Everdure by Heston range will prove to be a long term winner for the company and its now long suffering shareholders. A turnaround in the share price could take at least 18 months.

Market uncertainty about dividends and the fact the price has cratered make shareholders uneasy. It would be reasonable to expect a response to the current crisis from Shriro’s board and that could be restating the company’s dividend policy which has stood at a 60-70% payout ratio.

If this were the case for the current half, then an envelope back calculation suggests a final dividend payout could be as much as 4 cents, instead of an anticipated 6 cents. The proviso is the company’s financial position does not further deteriorate between now and the end of the year.

So it does look like Shriro can pay reduced dividends from profits.

The company’s balance sheet is in good order. It has solid net assets of nearly $54 million and no intangibles. Gearing is also exceptionally low with a net debt to net debt plus equity ratio of 15%.

Taking into account restructuring costs, Shriro can afford to do a share buyback at these prices. This would help stabilise the company’s share price. And it is a very rare occurrence a company can buy shares at a discount to its stated Net tangible asset backing. I can’t think of an occurrence where this has occurred in recent memory.

Shriro has a number of institutions on its share register who are generally pretty unforgiving with profit downgrades. And they vote with their feet. If any of them need to sell because SHM has fallen outside of investment mandates the share price could fall further.

So for the moment I am awaiting developments. The profit downgrades will prove either a gift horse or VIP dog food!

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